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Advanced Technical Analysis



Note: the following analysis is formulated as an assimilation of Fibonacci, DeMark, Elliott Wave and other technical indicators. It is offered as education and not intended as advice in any way.

Much of late last week's action was muted owing to both the holiday volume (low) and the meaningfully positive seasonal bias to the final 10 days of December. We have already laid bare much of the argument in favor of some degree of meaningful peak being formed here: (1) the plethora of record sentiment readings, (2) the weekly and daily DeMark trend exhaustion signals that have recently registered, (3) the daily and weekly momentum divergences on these new peaks, (4) the number of buying climaxes over the last 4 weeks, (5) high beta indices are lagging behind the blue chips, and (6) finally the Elliott wave and Fibonacci analysis which suggests that this area, particularly in the SPX (as well as the Russell 2000 - see our recent note on this index), is an important area for major resistance. Further, all of the minimum wave "constructs" are in place from the October 2002 lows, the March 2003 lows, and potentially from the August 2004 lows, to consider the entire advance from October to be potentially complete.

The only thing to do is to patiently await (1) the short term pattern to give way to the larger bearish forces at work in the weekly and daily chart OR (2) for short term prices and technicals to exhibit impulsive strength that would suggest the market is headed toward the next layer of Fibonacci resistance in the SPX 1250-1260 area that we outlined in our November 5th note. For now, given points 1-6 above, the odds squarely favor the more bearish potential so we'll continue to look for a 5 wave impulsive move down to signal that a potentially meaningful decline is underway.

The short term gauges that we look at are mixed: hourly DeMarks are not signaling either an imminent trend reversal nor an upward continuation; momentum divergences are there but not necessarily "classic" (read: large), breadth nearly put in a new peak on 12/21 but still failed to exceed the peaks on 11/24 (NDX breadth hasn't come anywhere close), ticks are diverging nicely, but volatility, which has plunged 18% in the last 5 sessions, is in fact confirming these new price peaks in the SPX and INDU.

Those short term indicators then suggest that patience is still the order of the day: prices are struggling to move higher and are doing so in an overlapped fashion; it is likely that further choppy gains are needed to complete the short term wave structure but those gains should not be meaningful nor easy to come by. So for now the shorter term view based on the analysis remains the same: patience is warranted here and, for those with a time frame shorter than at least 2 months, remains flat (those with a time frame longer than 2 months may consider layering into positions based on the scenario discussed).

With respect to volatility we would note the following. For three straight days last week (12/21-12/23), the VXO closed below the 2 standard deviation Bollinger band (on average 3.76% below). Looking back over the last 10 years of price data, we found only a handful of times when the VXO exceeded either one of the 2 standard deviation bands (upper or lower) and each instance was when the manifest fear in the market and the VXO was spiking above its upper Bollinger band. Was it a time around the October 2002 lows? No. The March 2003 lows? Nope. The times were: (1) immediately after the 9/11 attacks once the stock market opened, (2) the February 20-22 2001 period as the market kicked off its 2 month 21% plunge, (3) as the market was finishing up its first real decline (-15% in 1.5 months) after the bubble burst in September - October 2000, (4) the 21% one month decline in August 1998, and (5) the 13% 21 day decline in October 1997.

In each of these instances there were macroeconomic shocks to the economy and/or financial system that were causing investors to panic sell their holdings. But this time, in December 2004, the VXO has managed to exceed its lower Bollinger band for three straight days (and do so in a meaningful way) because investors are in a panic to BUY. Think about this for the moment. For all the bullishness in action and words in the last 10 years, there was not a single instance where the VXO exceeded the 2 standard deviation lower Bollinger band for 3 straight days. Not one. The only times when this took place were proximate to major bearish dislocations in the markets (and were, of course, near perfect times to buy stocks, at least for the short term.) Say what you want about the volatility index not being a good timing indicator. When it has exceeded its 2 standard deviation Bollinger band for 3-4 days in the past, it has been a good time to do the opposite of what everyone else was doing. Add this data to the many data points that suggest that we are in entirely uncharted (and risky) waters here.

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